Fathom Newsletters

The recession cat is out of the bag - both Mervyn King and Gordon Brown have announced that a recession now seems likely in the UK. It cannot be very often that both a serving Bank of England Governor and the Prime Minister have moved ahead of the data and much of  the markets in announcing a recession. Perhaps they were trying to draw some of the sting out of tomorrow's much-awaited preliminary GDP release which is widely expected to show the first contraction in UK GDP since 1992, and which both men may have already seen.

But how bad will it be? In the section below we take a look at past UK recessions as a guide. If you have any comments or questions please contact us at enquiries@fathom-consulting.com or call on +44 207 796 9561.

It is getting harder to find new phrases for how quickly the UK economy is deteriorating, but this morning’s data suggest we need to keep trying. In the first section below we highlight the growing case for a bold move at next week's MPC meeting - time is not on the MPC's side. 

This week, we also highlight the fact that pension deficits are widening once again - with little respite in sight. We model the typical pension fund scheme as a means to analysing the aggregate problem. That hypothetical scheme was more than fully funded at the end of June last year. Since that time, as equity markets have fallen and as bond prices have risen, the funding position has deteriorated dramatically. 

Our final section considers the apparent anomaly in market pricing whereby US banks stocks are outperforming their European counterparts, even though CDS rates suggest that US banks face far greater financing costs.

As always, comments/questions welcome. Please write to eenquiries@fathom-consulting.com or call +44 20 7796 9561.

A few weeks ago we asked whether it was time to buy equities (see here) the reason being that one of the most popular equity buy-sell indicators, the ratio of the yield on a government bond and the equity dividend yield, was saying that it was a very good time to sell government bonds and buy equities. Luckily, we also said that we thought that this message should be ignored!

Now, another old market maxim is indicating that the time is right: Lord Rothschild's oft-quoted remark that one should buy on the sound of cannons, and sell to the sound of trumpets. Originally a reference to shooting wars, it has since come to be used as a guide to trading stocks in relation to recessions. The sound of cannons being the start of the recession. Last week, we received confirmation that the UK recession has started. Our long-standing view has been that the US recession actually began in the final quarter of 2007, a point partially masked by the fiscal stimulus package, until this week's data signalled that the US recession is back on. With the euro area and Japan unlikely to be too far behind, we have cannons to left and cannons to the right, would it be foolish or wise to go riding through the valley of equities?

The short answer is, it depends on the nature of the recession now unfolding. As we show in the sections below, a deep recession would imply waiting; whereas a shallow but drawn-out recession would suggest that now might be the right time to start building a position. However, there is a potential caveat emptor: past recessions which have been associated with prolonged periods of deleveraging, e.g. Japan in the 1990s and the Great Depression, have also been associated with sustained weakness in share prices for much longer periods of time than regular recessions. Much of this boils down to one question: has the unprecedented rise in equity prices since the early 1980s been justified? If the answer is yes, then there is no reason to expect these measures to move back to post-war average levels. But if the answer is no, because the boom since the early 1980s has been dependent on increasingly cheaper credit as inflation and hence nominal rates have fallen, then the current bout of deleveraging could pose a significant risk to equity prices.

If you like any further information about this or any other Fathom model, please contact us at enquiries@fathom-consulting.com or call  +44 207 7969561 .

One of the most popular equity buy-sell indicators, the ratio of the yield on a government bond and the equity dividend yield, suggests that now might be a good time to sell government bonds and buy equities. That ratio is currently very low. Traditionally institutional investors, particularly UK pension fund and life companies, set equity buy and sell thresholds around this ratio.  But below we argue that this may be a good time to ignore this signal.

If you have questions or comments on this or any other Fathom reasearch, please contact us at enquiries@fathom-consulting.com or call +44 207 796 9561.

In collaboration with Cass Business School last week we published a paper on the extent to which combining alternative asset classes and strategies could reduce risk via diversification.  Our results indicate that 40% of time series risk can be eliminated by combining 8 alternatives, but only a further 4% from combining 12. 

We also find that an investor could reduce 65% of the dispersion in terminal wealth of an alternative investment basket - which is arguably what investors should really be concerned with - by combining 8 of these less conventional asset approaches to investment, but only a further 15% by combining 14.  For a copy of the full paper which contains more detailed results, please contact Alex Vitillo at Fathom (alex.vitillo@fathom-consulting.com; +44 207 796 9563).

Pointing out that UK monetary policy is no longer boring is itself getting boring, but last week's events really were quite interesting. Having delivered its largest ever single policy move, the MPC will be under a brighter than usual spotlight when it unveils its latest forecasts and thinking at the regular Inflation Report press conference this week. Given that in August, the committee's best guess was that output would be 'broadly flat', albeit with downside risks in the medium-term with rates at around 5%, there has obviously been a pretty dramatic re-think. It goes without saying that there has been more than enough 'news' since August to justify rolling out Keynes's famous dictum about the facts changing.

But in our view the far bigger revision required is to the MPC's thinking about inflation. Back in August, the committee assigned a less than 5% probability (indistinguishable from zero) to the risk that CPI inflation would be below 1% by the third quarter of 2009. We would now put that risk at above 70%. Our latest forecast sees CPI at 0.9% in September 2009, prompting another open letter, but this time in the opposite direction. That will undoubtedly be embarrassing for the MPC - at that point, Oscar Wilde's dictum about misfortune and carelessness might be more apt than Keynes. But of probably more significance for the broader economy's performance, we are now firmly of the view that RPI inflation will  by then have slipped decisively into deflation. We now see RPI inflation hitting -2.6% by September 2009. RPI inflation was last negative in 1943; and was last as negative as our forecast in 1933.

To some, this may sound like an alarmist forecast, but it is already priced in, in some parts of the market. Any student of economic history needs little prompting about the dangers of debt-deflation. But for younger readers, we reproduce the key message from Irving Fisher's seminal paper on the subject from 1933. 

If you would like to know more about this forecast or would like to arrange a presentation, please contact us at enquiries@fathom-consulting.com; or call Alex on +44 207 7969561.

As ever please send any comments/questions to enquiries@fathom-consulting.com or call 0207 796 9561.

The past week has seen governments around the world step up to the challenge of unblocking the global financial system. In the first section below we discuss the markets' so far muted response to this unprecedented level of political agreement on the way forward.

The principal reason for the markets' skepticism seems obvious enough - it's the economy. Next week, preliminary data for Q3 GDP will be released in the UK. A contraction seems almost certain. On the back of a flat second quarter, this will be seen by most as confirmation of the UK's first recession for 18 years. Others will follow. At this stage the big unknown is how big, deep and long a recession is likely to unfold. There are both positive and negative signals out there. On the positive side of the ledger, monetary policy has already reacted and can react more, especially in the UK and Europe. Fiscal policy is also being made to work. On the negative side, this recession looks like it will be truly global. And perhaps most significantly of all, it could be accompanied by widespread deflation. Debt and deflation make very unpleasant travelling companions.

This week we launch a new regular feature, Fathom Inflation Trends. Our first issue makes for pretty grim reading. We are forecasting outright deflation in both the UK RPI and the US CPI by mid 2009. Euro area inflation is also expected to decline rapidly as base effects from lower oil and food prices kick in, but we do not expect headline CPI to fall much below 2%. The attached presentation provides the details of our forecast, and the final section below outlines the key points.

If you have any questions or comments. or would like to know more about our inflation outlook, please contact us at enquiries@fathom-consulting.com or call +44 207 796 9561.